Central bank digital currencies: why you might end up missing cash

A central bank digital currency could be coming to a wallet near you. Why are some of the world’s biggest economies so eager to introduce them?

Central bank digital currencies                                 

Right now, many of the world’s biggest economies are embroiled in a race to become the first with a central bank digital currency. As you might expect, China has been working overtime to establish a firm lead. The digital yuan is currently being put through its paces in cities nationwide, all with a view to the CBDC being launched before Beijing hosts the Winter Olympics in 2022.

But what is a central bank digital currency, and why are major financial institutions treating them with such enthusiasm? What’s wrong with the infrastructure that the world has now? Here, we’re going to shed a spotlight on the futuristic world of central bank digital currencies – and explain why the pound (or dollar) in your pocket might not be there for long.

For starters, a central bank digital currency definition

Let’s begin by examining what a central bank digital currency actually is. The first thing to remember is that CBDCs can take different forms. While some may be classified as being “retail”, meaning that they’re designed to be used by everyday consumers like you and me, others are “wholesale” – assets that are solely intended for financial institutions.

In their simplest form, a central bank digital currency is an electronic version of fiat money. Right now, 3.9 billion banknotes are in circulation in the UK across all denominations, and keeping everything moving is a Herculean task for the Bank of England. One of the biggest challenges is clamping down on fraud – as every year, hundreds of thousands of forged banknotes are seized. Hi-tech security features have been added to modern notes at great expense to deter counterfeiters, but it isn’t going to stop them trying.

A CBDC could help eliminate this problem because money would be issued electronically by a central bank instead. This would be far more than numbers on a screen. Each unit of a digital pound, dollar or yuan would likely have its own unique identifier to prevent it being imitated.

Of course, there are other reasons why central bank digital currencies are being pursued with such enthusiasm. The Bank of England, one of the institutions which is looking into the feasibility of CBDCs, acknowledges that we are living in a time of “significant change in money and payments.” In recent years, debit cards have overtaken cash as the payment method of choice for the very first time. It believes an official digital asset could make cross-border payments faster and cheaper, and help the economy respond to changing consumer habits as online shopping becomes ever more popular.

And when you look at some of the data underpinning exactly how these habits are evolving, you begin to understand the urgency surrounding central bank digital currencies:

Why the sudden interest in CBDCs?

It’s fair to say that central banks have ramped up their efforts to create digital currencies because of how the crypto markets continue to gain strength. Although Bitcoin isn’t necessarily illegal in most major economies, innovation in this industry has been stymied by regulation, and many top central bankers have publicly taken a dim view about these assets. As Bank of England Governor Andrew Bailey said: “If you want to buy Bitcoin, be prepared to lose all your money.” 

Other threats on the horizon have included Facebook’s plans to launch a private digital currency called Libra. Central banks in Europe and the US reacted with a sizeable amount of alarm when the project was first proposed – mainly because they were concerned that a stablecoin available to millions of people would threaten monetary sovereignty and even risk destabilising the global economy. Libra has now gone back to the drawing board and watered down its proposals substantially, buying central banks some precious time as they race to catch up.

There’s also considerable worry about the consequences of China being the first to launch a central bank digital currency – with some wondering whether this would allow Beijing to achieve the type of dominance that the US has seen with the almighty dollar. Top officials in the People’s Bank of China have raised eyebrows with some of their statements about the upcoming digital yuan, with one central banker proudly proclaiming that it would unlock “controllable anonymity”. Some critics interpreted this as a warning that the country intends to monitor the transactions of consumers, infringing their privacy. Cash may be inconvenient in a digital age, but at least banknotes can be exchanged with a greater level of discretion.

Even though the US and China have been at loggerheads for a myriad of reasons in recent years, with tensions flaring during the Trump presidency, Washington hasn’t really been in a rush to explore the merits of a digital dollar. Indeed, last December, Treasury Secretary Steven Mnuchin said he believes the country won’t need a CBDC until 2025 at the earliest. It is worth noting at this point that circumstances have changed over the past few months because of the coronavirus pandemic. With some Americans struggling to access the stimulus checks they’re entitled to, Congress has ramped up hearings about the merits of a digital dollar once again.

The downsides of a central bank digital currency

Innovation isn’t always a good thing – and there are some serious disadvantages to a CBDC achieving widespread adoption, causing the humble banknote to go extinct. Unless they are simple and easy to use, these digital assets could actually prompt a massive step back in the quest for financial inclusion, alienating older consumers. (This is why some nations have enforced or are considering legislation that will ensure it is mandatory for shops to continue accepting cash.)

Another drawback is how a cashless society could actually increase inflation. Banknotes, and their denominated value, can be quite significant psychologically. That’s why many shops advertise their products at a price of £9.99, as shoppers see it as somehow significantly different from £10. In Japan, hungry workers have been able to get a lunch deal using their 1,000 yen note (worth about £7.19 or $9.46) for years, with restaurants and cafes reluctant to push up the prices any further for fear of driving away custom. If the country fully embraced central bank digital currencies, you could argue that there would be little to stop them from charging much more than they do now.

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